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Brussels, 10 September 2008

EU interim forecasts: sharper-than-expected slowdown

Economic growth is expected to post 1.4% this year in the European Union (1.3% in the euro area) - around ½ percentage point less than forecast in April. The main downside risks identified in the spring forecast have materialised, with the financial turmoil deepening, commodity prices soaring and the shocks to several housing markets spreading more widely. Inflation is expected to average 3.8% in the EU and 3.6% in the euro area this year following the continued strong rise in commodity prices. This represents an upward revision, although inflation could be at a turning point as the impact of past increases in energy and food prices gradually fades in the coming months.

"The continuation of the turmoil in the financial markets one year on, the near doubling of energy prices over the same period and the correction in some housing markets have had an impact on the economy, though the recent fall in oil and other commodity prices and the easing up in the euro exchange rate have provided some relief. In this difficult and uncertain environment we must learn from past mistakes and keep a steady course of action. Moving ahead with Europe's reform agenda is crucial to continue creating jobs and to cope better with external shocks. We must speed up the implementation of the road map to help restore confidence in the financial markets, and preserve the improvements in public finances so as not to increase the burden for future generations, which will already face the challenge of an ageing population," said Joaquín Almunia, Economic and Monetary Affairs Commissioner.

As the global headwinds intensified, output has started to fall in several advanced economies in the second quarter of this year, caused also in some countries by a bust in the housing sectors. GDP contracted by 0.1% in the EU and by 0.2% in the euro area. This partly reflects a payback following an unexpectedly strong growth in the first quarter, which was due to temporary factors to a certain extent. In addition, the continued rise in commodity prices, the ongoing financial turmoil and, in some cases, a housing shock caused confidence to deteriorate, capital costs to increase further and consumer-price inflation to surge, putting a brake on domestic demand.

For 2008, the Commission’s Economic and Financial Affairs Directorate General now forecasts growth at 1.4% in the EU and 1.3% in the euro area, which represents a 0.6 and 0.4 percentage point (pp.) downward revision, respectively, compared to the spring forecast. This is calculated on the basis of updated projections for France, Germany, Italy, the Netherlands, Poland, Spain and the United Kingdom, that together account for about 80% of the EU’s GDP.

External conditions increasingly unfavourable

The global economic situation and outlook remains unusually uncertain. One year after the outburst of the financial turmoil, the situation in the international financial system continues to be fragile with several key credit markets still severely disrupted. Commodity prices, especially energy and food prices, have soared since the last quarter of 2007, fuelling inflation – even if oil and other commodity prices have come down from their highs earlier this summer. Business and consumer confidence have declined significantly, to levels well below their long-term averages. While growth has remained robust so far in emerging economies, a global economic slowdown is looming on the horizon.

The European economies were generally sound prior to the outburst of the financial turmoil last summer. There were no major imbalances in the EU and the euro area as a whole, although this may not have been the case in all sectors and Member States. Activity held up relatively well, while the financial distress had an immediate adverse impact on some confidence indicators. As the global headwinds intensified over the past quarters, however, the fall in confidence indicators became more broad based across sectors and Member States (with particularly sizable decline in the overall economic sentiment indicator in the UK and Spain). Eventually, activity measures also started to weaken. Various indicators, such as industrial production, orders and retail sales, point to a deceleration in the underlying growth momentum in both the EU and the euro area in recent months. Recent surveys also suggest a bleak outlook for the EU economies going forward.

The projected easing of inflation, which is expected to support households' disposable income and consumption to a greater extent during the fourth quarter, is one of factors that may bring about a turn in the trend.

Inflation at a turning point

Fuelled by high commodity prices, consumer price inflation continued to pick up in recent months. The contributions from energy and food prices to headline inflation increased significantly and amounted to 1.7 pps. and 1.2 pps., respectively, in July. The headline inflation rate decelerated slightly in August, to 3.8%, in the euro area, down from the record-high level reported in July (4.0%).

The upwards revision of inflation reflects the worse-than-expected outcome since the spring forecast. The gradual fading of the impact of past increases in energy and food prices in the coming months suggest, however, that inflation could be at a turning point. Nevertheless, future developments in commodity markets, as well as the capacity to contain second-round effects, will be key for the inflation outlook in both regions.

Risk assessment

The risks to the growth outlook stay tilted to the downside. In particular, developments in commodity and financial markets will continue to be the key factors shaping the growth outlook and the technical assumptions could also surprise on the negative side as they have done in the recent forecasting exercises. Other risks relate to the underlying strength of the US economy, new calls for protectionist and other trade-distorting measures, but also to the capacity of some of the EU economies to adjust their internal and external imbalances. The risks to the inflation outlook appear somewhat more balanced, albeit they are still tilted to the upside. In particular and even if economic activity is set to slow sharply, the risk of second-round effects can not be excluded, although there is no evidence of any wide-spread such effects so far.

More detailed report available on:

Table 1: Real GDP growth
[ Figures and graphics available in PDF and WORD PROCESSED ]
Note: the quarterly figures are working-day and seasonally adjusted, while the annual figures are unadjusted.

Table 2: Consumer price inflation
[ Figures and graphics available in PDF and WORD PROCESSED ]

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